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Preparing for a layoff
Dear Money Matters,
I work in the telecommunications industry, and my company is having
layoffs almost monthly. I haven't been affected yet, but I want
to be prepared for anything. The severance package would pay me
through November, but I've also been saving in case of an emergency.
I've placed the funds in a money market account and have $3,000
saved up. I'm also contributing $250 a month to it. Should I withdraw
a portion of the funds to help pay off a credit card? The card is
the only debt that I have besides my car. I really would like to
get rid of this debt, but I don't know if I should use my savings
to do it.
LT
Dear LT,
First, I hope everything works out in the best possible fashion
for you. You're not alone in this sputtering economy. Countless
employees who thought their jobs were secure are now finding out
otherwise.
With that in mind, you're exceedingly prudent to
be hunkering down and expecting the worst. I would urge you to continue
feeding your emergency fund as much as possible. You'll be happy
you didn't shortchange yourself, should you have to rely on it for
living expenses.
However, whether you should earmark a portion of
your savings to help pay off a credit card depends on a variety
of factors. Under normal circumstances, it usually makes mathematical
sense to pay off the card. The reason is that you're likely paying
more in interest on the card than you're earning with a money market
fund. In fact, the disparity may be quite substantial. According
to recent averages, a standard credit card's interest rate was a
bit higher than 13.5 percent. By contrast, even a so-called "high
yield" money market savings account was only earning 2.53 percent.
Additionally, when investments in general are suffering due to poor
economic conditions, it's always a sensible play to begin paying
down all sorts of debt, including credit cards.
One element to your decision is the size of your
credit card balance. If it's only a matter of a few hundred dollars,
I don't think you'll suffer irreparable harm by pulling some funds
from your money market to kill that debt. However, if you're looking
at something approaching $1,000 or more, I would be a good deal
more gun-shy. However wise it is to pay off a high interest card,
you don't want to deplete your savings to a dangerously low level,
particularly with uncertain economic times on the horizon. Of course,
some would argue that a credit card paid down to zero could always
be used in a pinch down the line, but I've never felt using a credit
card for everyday living expenses was an appropriate choice.
There are, however, a few other alternatives:
- Pay down a portion of the balance: You don't
necessarily have to approach this with an all-or-nothing-at-all
attitude. If the balance is more than you feel comfortable taking
out in one shot, consider paring down your balance bit by bit,
adding more to your pay down as funds permit. That way, you're
at least shrinking your debt.
- Transfer the balance to a lower-rate card:
If you card is in the teens or higher in interest rate, look into
a card with lower charges. Bankrate's credit
card search engine can help you find a card that may be a
good deal less expensive in interest charges. But pay attention
to any annual fee that may be attached to a card; while the interest
rate may be low, you can lose a fair portion of your savings to
the yearly fee a company levies.
Use Bankrate's credit
card calculators to figure your interest rate savings and
how much, if at all, you may lose to annual fees.
- Get a home equity loan or line of credit: If
you own your own home (I know you say your debt is limited, but
many folks don't refer to a mortgage in the same manner), give
some thought to transferring your credit card balance to a home
equity loan or line of credit. For one thing, they're relatively
inexpensive -- the going rate for home equity lines of credit
is less than 5 percent, with certain loans going for less than
7 percent. Click
here to search for current home equity rates. In the case
of the line of credit, they can also offer a degree of payback
flexibility; while the loan incurs a fixed monthly amount, a line
of credit functions in a fashion similar to a credit card, fixing
monthly payments based on your outstanding balance. And, finally,
interest on both products, unlike credit card debt, is tax deductible,
which further limits your eventual out-of-pocket costs.
-- Posted: July 16, 2002
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